Cramer - Wrong! Rear Echelon Revelations: A Tour of the Fighting
Aug 12, 1998
By James J. Cramer
The combat between the bulls and the bears isn't decided on the vast
battlefield of the market itself. Small unit actions determine the
victors. The real triumphs tend to be obscured by the Averages, which showed, of course, that the market closed down yesterday. But, make no mistake about it -- in the trenches, the bulls won more than their fair share on Tuesday.
Let me give you a tour of the fighting at the 123 level of Merck (NYSE:MRK - news) from the point of view of a bear, so you can better understand what went on in the pivotal moments of Tuesday's action -- more than you would by reading the information dispensed under the "Down 100" headlines you will see in the morning paper.
On Tuesday morning, word leaked out that a German study would show that Lilly's (NYSE:LLY - news) Evista was more effective against bone deterioration than Merck's Fosamax. As someone who is long Lilly, I thought this might be great market-moving news, as the rap against Lilly is that Evista hasn't taken off. People want to use it to combat breast cancer, but there are no long-term studies of its value. In the meantime, it's been seen as second banana to Merck's drug in its principal use against osteoporosis.
As I am neither a bull nor a bear but an opportunist, I immediately priced out Merck puts to make a bet against that drug giant. The drug stocks have acted terribly and Merck had just rallied quite a few points off of its 119-and-change bottom and I figured that it was due for a pullback anyway. I thought that without the buyback that Merck announced at the end of July, this stock was history.
Later in the morning, when I was certain the day would be ugly, but after the SPX futures had reached the down-27 limit and subsequently rallied, I purchased 500 Merck August 130 puts for $7.50 with the stock at 123.5. I paid a point over parity to the common (130 - 7.5 = 122.5), betting that the stock would continue to decline after the market started heading back down. Almost immediately, the direction of the trade was a winner, as Merck dropped a half of a point. The direction of the trade was a winner -- not the trade itself, as the put gained only about a quarter of a point. (It can't gain one-for-one when you have paid a point of premium.)
No matter, Merck trades with the programs, and I figured that once the futures tested that down-27 limit again -- with no collar stopping them this time for as far as the eye could see -- Merck would drop into free fall and I could have a nifty gain. Why should the market stop going down? That's all it seems to do in the afternoon anyway.
Sure enough, in the split second we were retesting the most awful moments of the day, Merck started sliding. When I was up a dollar, with the stock at 121 and change, I went in to sell some of the puts. I figured, What the heck, if for whatever chance this market held a level everyone thought couldn't hold, I didn't want to be short a stock that could rocket with the inevitable buy programs triggered by holding that down-27 level on the SPOOS.
Then I got lucky, as a huge institutional seller of Merck appeared, one of those giant capitulation jobs that CNBC keeps saying aren't happening, but were actually happening all around us Tuesday and were available for anybody to see. Only the press doesn't see them. They aren't on the trading desks.
My first reaction was to pull my sell order, as I figured there was no way this guy doesn't kill the stock. But then, out of the corner of my eye, I saw the futures holding down about 27, which I did not think would occur given all of the gloom. So instead, I offered up all of the puts and immediately sold them for about $8.50, making a point.
Boom! The block of several hundred thousand shares trades at around 121, and immediately I am kicking myself that I did not buy common instead of selling the put. I could have gotten long Merck at the equivalent of selling the put at about $8.87 (130 - 121.125 = 8.87, which is three-eighths better than I did on the put). Then I start thinking, Whoa, why did I cover it at all? No way that print is going to hold. No way Merck doesn't drop another couple of points now that this big piece of supply is hanging out.
Wrong!
That piece was the bottom. Merck held. Anybody who bought on that print left the table making a couple of bucks almost immediately, as buyers rushed into this blue-chip name and futures-buying topped it. From the looks of things, Merck had a bad day, but you could not have made another dime short it than I did. But you could have made good money buying it on the print. That's positive from a trader's point of view. And you got the capitulation you needed in this stock. It now joins my list of stocks I don't want to short, as there is clearly demand for the name below the market.
Why is this small unit battle over Merck so important? First, it is a true depiction of the trenches, away from all of the highs and lows and recommendations and downgrades and strategists and analysts. Second, this same kind of battle played out all over the Street yesterday. I saw similar skirmishes initially won by the bears in Pfizer (NYSE:PFE - news) , Schering-Plough (NYSE:SGP - news) and Hewlett-Packard (NYSE:HWP - news) , only to see them reversed simultaneous to the Merck turnaround.
As I have said over and over again, you will not get a bottom all at once in stocks. We have had our bottom in old tech, which will be tested Wednesday by the downbeat Applied Materials (Nasdaq:AMAT - news) call. We may have had our bottom in integrated oils, courtesy of the embarrassing Deutsche Bank downgrade (to sell) of Amoco (NYSE:AN - news) on the day it gets a bid from British Pete. And I am thinking that we may have had a bottom in the drugs courtesy of the small unit victories I saw in the names in the afternoon on Tuesday. I know, I know, you would love me to say, "Everybody in, it's the bottom." But I am not one of those wind-up strategists that reiterates his stance from a pay phone on the road to Vienna or changes his mind after a bad
night's sleep on the chart of Procter (NYSE:PG - news) . I am trying to make money in individual stocks, and Tuesday I was glad I did not stay short Merck.
Random musings: See you on Squawk.
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com. At the time of publication the fund was long Pfizer, Eli Lilly and Schering-Plough, though positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a
solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to TheStreet.com at letters@thestreet.com.
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